The microfinance movement began in south Asia when Muhammad Yunus started Grameen Bank in Bangladesh in the 1970’s. He was awarded a Nobel Prize for his efforts in helping bring women out of poverty in that country. It has been a successful experiment in social lending extolled by the likes of Bill Clinton, Kofi Annan and many other world leaders.
These days, however, microfinance is starting to lose its luster. In the last month there have been several news stories on the dark side of microfinace. There was this story on NPR, the New York Times and Vator.tv and many others. The basic problem is this. The interest rates charged by lenders in these countries are exorbitant and they are given to poor people who typically have little or no business experience. It has become a huge business, particularly in India, run by large corporations focused on short term financial results. Sounds like a recipe for disaster and that is what is happening. All this negative news prompted this response from Yunus in the New York Times last week.
In the Indian state of Andhra Pradesh, home to 75% of the microfinance companies in India, the state legislature has passed a new law that will likely send most microfinance companies out of business. Of course, like any industry there are many reputable companies that have been caught in the crossfire, and there have certainly been many success stories. But with many women being driven to suicide because of their mounting debts something had to be done.
The problems stem from the predatory lending practices in place at many of these microfinance companies. While the average interest rates are not exorbitant, in the 24-30% range, some lenders are charging 70% or more. What is worse, though, is that uneducated women are encouraged to take out more loans than they could possibly afford to pay. The money is often used to pay for health care or groceries (or other loans) rather than as seed money to start or expand a business.
Where is Kiva?
I keep expecting to see an article on Kiva’s blog addressing these issues, but no such article has been forthcoming. I know they don’t have operations in India so maybe they think it is not that relevant to them. But with all the negative press about microfinance I don’t see how they can continue to ignore it. I would have to think it is impacting the amount of new lenders coming on board with them.
One great part about Kiva is that they do try to be transparent about their field partners. These are the companies that are basically getting free money from the lenders on Kiva and then lending it out and charging interest. You can go to Kiva’s Field Partners page and see the success rate of different companies. Some have very impressive records while others are only average. I have been a Kiva lender for several years and I only fund loans that will be administered by successful field partners.
Lessons for P2P Lending
Let me be clear about one thing, microfinance is not peer to peer (p2p) lending, and microcredit in India has very little in common with p2p lending in this country. Rob Garcia of Lending Club wrote this excellent article a few months ago explaining the differences between microfinance, p2p lending, and crowdfunding. Despite all this, I fear that the general public doesn’t make that distinction. Many people don’t understand these differences, they may see the problems in India and think I better steer clear of these microlenders like Kiva, Prosper and Lending Club (even though the latter two are not microlenders).
There are so many differences even between Kiva and the leading p2p lenders. The average loan size on Kiva is $382, on Lending Club it is $10,078 (2010 average) and on Prosper it is $4,916 (2010 average). Peer to peer lending is about lending money between individuals. Most microfinance is run by companies lending money to people, and even though the seed money for these loans may come from individuals through not-for-profit organizations like Kiva, many of the microfinance companies doing the actual lending are for-profit institutions.
A Loan Should be a Win-Win Deal
Like all business dealings, lending money, whether it be a couple of hundred dollars or several thousand dollars, should be a win-win for both sides. If we start to focus on one side of the equation, then the long term viability of the business becomes questionable. This is what has happened in India. The lenders were not interested in a win-win loan, they just wanted to make the loan and collect their commission.
Peer to peer lending is different. While there will always be some people looking to game the system, the vast majority of people involved are looking for a win-win situation. Borrowers want a loan with a lower interest rate than they would pay for a credit card loan (since most banks aren’t doing personal loans these days) and lenders want a better investment return on their money. The p2p lending facilitators (Lending Club and Prosper) need both the borrowers and lenders to be successful so they can continue to grow and take their small slice of the pie. In most cases these days all parties are getting what they want.
I hope that the micr0finance industry in south Asia can get their act together and create a sustainable win-win industry. But I think it behooves the p2p lending industry to not ignore this crisis. In marketing, perception is everything, and p2p lending wants to continue to be perceived as an industry benefiting all parties.